Restraint of trade – how far can it stretch ?

30-November-2010 Commercial Disputes,General By admin

Solicitor resigns and fights against signed employment agreement

In recent years the pros and cons of employment contracts have been hotly debated. When a solicitor in a country town resigned from his firm to work for another he was accused of being in breach of his employment contract. It was up to the Supreme Court of New South Wales to decide what “restraint of trade” in employment agreements could apply to the solicitor and what was unreasonable.

Explanation of restraint of trade

A common term of an employment contract, or contract of sale of business, is a “restraint of trade”. These clauses restrict or limit the competitive activities of the seller or the employee. This is to protect the goodwill and “value” of the purchaser. A 2010 decision in the Supreme Court of New South Wales shows the limitations of these clauses being binding.

The facts of the employment contract

M was employed as a solicitor by a firm in Taree and had signed a contract of employment.  The contract of employment contained three restraints which were to apply following the cessation of employment. These were to apply whether he resigned, was dismissed or they agreed on a mutual termination. 

The restraints were:
  1. Prohibition against soliciting clients of the Firm. (A client of the firm was defined as someone who, at termination or during the preceding one year, had engaged the firm). 
  2. Prohibition against soliciting employees to leave the firm and related companies. 
  3. Prohibition on engaging in “Competitive Activity”. The definition of competitive activity is “any activity which involves carrying on either alone, as a director or in partnership with any person or persons or as an employee of any person or persons the business or profession of a lawyer within 10 kilometres of the post offices at Taree or Wingham”.

On or about 27 November 2009 M resigned his employment from the firm.  He expected he could stay in the town where he lived and obtained employment with another local firm.  His previous employer commenced proceedings. They sought to restrain M by Court order from working for his new employer due to it being a contravention of the employment agreement.

Case facts

M ceased employment with the firm on 27 November 2009.

Clause 13 of his contract of employment imposed three restraints, each of them to be effective for 12 months.

His Honour Justice McDougall restated the rule that a restraint of trade could be justified insofar as it is no more than is necessary for the reasonable protection of the legitimate interests of the plaintiff.  In the circumstances and in the particular facts of this case, the plaintiff’s interests were identified as the goodwill of its legal practice.  The plaintiff identified a legitimate interest that was capable of being the subject of restraint and led evidence that the firm had introduced the employee to clients of the firm.

M offered undertakings to the Court to abide by the second restraint of not soliciting other employees to leave. The scope of the second and the third  restraints were what were being questioned.

In respect of the First Restraint, His Honour was asked to determine whether or not the restraint against solicitation should be limited to clients of the firm for whom the defendant had provided legal services. In it’s original form it was worded to extend to all clients of the firm generally. That is any client of the firm whether or not the employee had any contact or association with the client.  His Honour determined (at paragraph nine) that the restraint should be limited to the solicitation of clients of the firm for whom the defendant had performed work (or legal services) in the preceding 12 months.

In deciding how long this restraint should take place His Honour considered this to be a question partly of principle and partly of fact.  His Honour found support in the view that the length of time should reflect the amount of time taken to end the connection between the client and the employee and how long it would take to train up someone else to fill the employee’s place.  His Honour found 12 months to be justified on the evidence.  Accordingly His Honour read down the restraint against solicitation of clients with whom the defendant had not worked with.

The Third Restraint was the most contentious. It provided a prohibition on competition on an absolute basis within a 10 kilometre radius of the designated places. This was not only a restriction on acting for clients of the firm but anyone (and everyone) else within this area. Taree and the surrounding countryside has a population of 48,000. Due to the size of the town the 10 km restraint covered the entire town.

His Honour was mindful that it was his role to assess what was reasonably necessary in all the particular circumstances of this case having regard to the application of principles established by previous cases.

His Honour found that the Third Restraint was a blanket covenant against competition. It protected not only the plaintiff’s legitimate interests in its own clients but also competition in respect of those who are not, nor had never been its clients. His Honour found that the Third Restraint went further than was reasonably necessary for the protection of the firm and did not consider this restraint reasonable.

His Honour also determined the question of costs.  Acknowledging that costs generally follow the event and each party had had a “measure of success”. Nevertheless, His Honour ordered that the plaintiff pay 80 percent of the defendant’s costs of the proceedings.

Comment from Mark Streeter

The Restraint of Trade Act 1976 (NSW) is a very small piece of legislation.  The full Act is only four sections. The Restraint of Trade Act provides that ‘Restraints’ are valid to the extent to which it is not against public policy, whether they are in severable terms or not and empowers the Supreme Court to set aside a restraint of trade on the basis that it is offensive to public policy.

Sub section 4(3) provides that the Supreme Court may, on such terms as it thinks fit, order the restraint be invalid or accordingly valid only to the extent the court thinks fit.

How does a Court determine whether or not a restraint of trade infringes public policy?  This judgment provides a good example of the principle. The Act is not limited to employment contracts but could also be applied to shareholder agreements or partnership contracts.

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